NONA ONNELA
DETERMINING THE OPTIMAL DISTRIBUTION CENTER LOCA- TION
Master of Science Thesis
Examiner: Prof. Jarkko Rantala.
Examiner and topic approved by the Faculty Council of the Faculty of Business and Built Environment on the 4th of February 2015.
ABSTRACT
NONA ONNELA: Determining the Optimal Distribution Center Location Tampere University of Technology
Master of Science Thesis, 89 pages, 23 Appendix pages May 2015
Master’s Degree Programme in Industrial Engineering and Management Major: Operations management and logistics + Freight transport systems Examiner: Professor Jarkko Rantala
Keywords: Facility location, Distribution center, Center of Gravity, AHP, Spare part business, Global supply chain, 3PL
The main research question of this thesis was: What is the optimal location for Kalmar’s European Distribution Center when quantitative and qualitative factors are considered?
The aim was to investigate whether or not the current location is optimal and if not, what would be a better location. In order to do that, relevant factors behind the location decision also needed to be determined.
This thesis is a combination of case study and action oriented study. It combines both, qualitative and quantitative methods. In the first phase, theoretical background was cre- ated for the subsequent empirical phase. It was done by using scientific literature as source material. The aim was to cover the most important themes of warehousing and location decisions in respect of the case company’s situation. The empirical part started with the description of Kalmar’s current supply chain. Then, challenges with the current distribution center location were determined through interviews and observations.
Quantitative data of shipments and their destinations was used in center of gravity cal- culations. The actual location of the center of gravity created a base for searching for a candidate service provider and determining the relevant factors. The factors taken into account were cultural and logistical. After that, the service providers’ competences were evaluated. Prices were taken into account as well. The results were then combined with the AHP method.
The result of the center of gravity analysis was a point in the western part of Germany.
After closer scrutiny, there occurred to be three possible new service providers within a reasonable distance from the center of gravity. However, the current EDC location was also considered a possible option, and thus there were four candidates. Two of them were in Germany, one in the Netherlands and one (the current) in France. Culturally and logistically the current location was considered the worst and the locations in Germany the best. The service provider in Germany, Mönchengladbach, was seen as the best op- tion also by its competences. Consequently, the most essential result of this thesis is that the optimal location for Kalmar’s EDC would be in Mönchengladbach. However, changing the location there is not the recommended action of this thesis. Relocating has numerous possible complications and thus its implications and costs should be scruti- nized more closely before any decision to change the location.
TIIVISTELMÄ
NONA ONNELA: Varaston optimaalisen sijainnin määrittäminen Tampereen teknillinen yliopisto
Diplomityö, 89 sivua, 23 liitesivua Toukokuu 2015
Tuotantotalouden diplomi-insinöörin tutkinto-ohjelma
Pääaine: Tuotannonohjaus ja logistiikka + Kuljetusjärjestelmät Tarkastaja: Professori Jarkko Rantala
Avainsanat: Varaston sijainti, gravitaatiomalli, AHP, varaosaliiketoiminta, glo- baali toimitusketju, 3PL
Tämän diplomityön päätutkimuskysymys oli: Mikä on optimaalinen sijainti Kalmarin Services-yksikön Euroopan keskusvarastolle, kun sekä määrälliset että laadulliset tekijät otetaan huomioon? Tarkoituksena oli tutkia, onko nykyinen sijainti optimaalinen ja jos ei, mikä olisi parempi sijainti. Jotta optimaalinen sijainti saatiin selville, täytyi myös määritellä tärkeimmät siihen vaikuttavat tekijät.
Tämä diplomityö toteutettiin tapaustutkimuksen ja toiminta-analyyttisen tutkimuksen yhdistelmänä, jossa käytettiin sekä laadullisia että määrällisiä tutkimusmenetelmiä. Dip- lomityön alkuosassa luotiin teoreettinen tausta empiiriselle tarkastelulle. Teoreettinen osio toteutettiin käyttämällä aineistona tieteellistä kirjallisuutta ja artikkeleita. Tarkoi- tuksena oli käsitellä käytännön ongelman kannalta tärkeimmät varastoinnin ja sijainti- päätösten teoriat. Työn empiirinen osuus aloitettiin Kalmarin nykyisen toimitusketjun kuvailulla. Tämän jälkeen määriteltiin nykyisen EDC:n sijainnin ongelmakohdat ha- vainnoinnin ja haastattelujen keinoin. Määrällistä, lähetyksistä kertovaa dataa hyödyn- nettiin gravitaatiomallin mukaisissa laskelmissa. Laskemista saatua painopistettä ja sitä ympäröivää erikseen määriteltyä aluetta käytettiin sitten pohjana mahdollisten palvelun- tarjoajien kartoitukselle ja tärkeimpien sijaintitekijöiden määrittelylle. Tekijät, jotka päädyttiin huomioimaan, olivat kulttuuriset ja logistiset tekijät. Tämän jälkeen arvioitiin palveluntarjoajien ominaisuuksia, kyvykkyyttä ja hintoja. Lopuksi tulokset yhdistettiin AHP-menetelmää käyttäen, jotta saatiin selvitettyä kaikki tekijät huomioon ottava opti- maalinen sijainti.
Gravitaatiolaskelmien tuloksena saatiin piste, joka sijaitsee Saksassa lähellä länsirajaa.
Tarkemman tarkastelun jälkeen huomattiin, että järkevän matkan etäisyydellä uutta mahdollista palveluntarjoajaa. Myös nykyinen EDC osui tarkastelualueelle, ja se otet- tiinkin mukaan vertailuun, joten yhteensä vaihtoehtoja oli neljä. Kaksi palveluntarjoajis- ta sijaitsi Saksassa, yksi Hollannissa ja yksi (nykyinen) Ranskassa. Nykyistä sijaintia pidettiin sekä kulttuurisesti että logistisesti heikoimpana. Vastaavasti Saksa oli näiltä ominaisuuksilta vahvin. Palveluntarjoajista parhaana pidettiin Mönchengladbachissa Saksassa sijaitsevaa tarjoajaa. Tämän diplomityön tuloksena olikin, että optimaalinen sijainti Kalmarin Services-yksikön Euroopan keskusvarastolle olisi Mönchengladbach.
Tämä ei kuitenkaan ollut sama, kuin työssä esitetty toimintasuositus, sillä sijainnin muuttamisella olisi paljon negatiivisia vaikutuksia joita pitäisi tutkia vielä tarkemmin.
PREFACE
This Master of Science thesis was made at Kalmar Services during eight months, be- tween September 2014 and April 2015. Writing this thesis was a challenging but also a very inspiring project, which is a great conclusion to my studies.
First, I would like to thank Professor Jarkko Rantala for his guidance during this process and for examining this thesis. Many people have helped and supported me also at Kal- mar. I want to express my sincere gratitude especially to Logistics Manager Seppo Haapala for providing the topic and necessary information and also for mentoring me during the process. I would also like to thank Logistics Engineer Toni Uskola for his contribution to my work.
I am deeply grateful to ThD Jenni Spännäri, who has given me priceless pieces of ad- vice on writing a thesis but whose comments also made me laugh. I also wish to express my appreciation to Susanna Yrjänäinen for her help with my English.
Finally, I would like to thank my friends and family who have always had faith in me.
My heartfelt thanks go to Lauri, who has supported me and promised that there will be champagne at our shared graduation party.
Tampere, 15th April 2015
Nona Onnela
SISÄLLYSLUETTELO
1. INTRODUCTION ... 1
1.1 Motivation ... 1
1.2 Case company ... 2
1.3 Research problem, objectives and restrictions ... 4
1.4 Research approach and methods ... 6
1.5 Structure ... 8
2. STRATEGIC WAREHOUSING AND SPARE PART BUSINESS ... 10
2.1 Warehousing functions ... 10
2.1.1 Balancing supply and demand ... 10
2.1.2 Maintaining service level ... 11
2.1.3 Reducing unit costs and adding value ... 11
2.1.4 Specialties of a distribution centre ... 12
2.2 Strategic warehousing ... 13
2.2.1 Optimizing service level and costs ... 13
2.2.2 Following the main strategy ... 15
2.3 Outsourcing the warehousing functions ... 17
2.4 The role of warehousing in spare parts business ... 21
3. OPTIMAL DISTRIBUTION CENTER LOCATION ... 23
3.1 Logistics strategy and warehouse location ... 23
3.1.1 Cost savings ... 24
3.1.2 Service level ... 26
3.2 Distance functions in location planning ... 27
3.3 Center of gravity method... 29
3.4 Location decisions in the global supply chain ... 32
3.4.1 Political and societal factors ... 33
3.4.2 Cultural factors ... 33
3.4.3 Logistical performance ... 35
3.4.4 Relocation complications ... 37
3.5 Analytic Hierarchy Process in location decisions ... 38
4. CURRENT SITUATION AT KALMAR ... 43
4.1 Supply chain in Kalmar Parts and logistics ... 43
4.1.1 Suppliers... 43
4.1.2 Sales offices and customers ... 44
4.1.3 Modes of transportation ... 45
4.1.4 Distribution centers ... 46
4.2 Qualities of the current EDC location ... 48
5. RESEARCH MATERIALS AND METHODS ... 51
5.1 Data analysis ... 51
5.1.1 Center of Gravity method ... 53
5.2 Evaluating service providers ... 55
5.3 Qualitative location analysis ... 55
5.3.1 Company X ... 56
5.3.2 MacGregor ... 57
5.4 Combining quantitative and qualitative results: Decision making with the analytic hierarchy process... 57
6. RESULTS AND DISCUSSION ... 60
6.1 Center of Gravity ... 60
6.2 Candidate service providers ... 63
6.3 Qualities of the candidates and their locations ... 64
6.3.1 Cultural factors ... 64
6.3.2 Logistical factors ... 65
6.3.3 Service provider competences ... 66
6.4 Combining the results... 67
6.5 The first phase: Determining qualities of the locations... 68
6.5.1 The second phase: Determining the optimal distribution center location 72 7. CONCLUSIONS ... 76
7.1 Main results ... 76
7.2 Recommendation for action ... 77
7.3 Assessment of the utilized methods ... 78
7.4 Assessment of the study ... 78
7.5 Recommendations for further studies ... 79
BIBLIOGRAPHY ... 81 APPENDIX A: Interview structure / Behrens and Interviewee 1
APPENDIX B: Interview structure / Interviewee 2 APPENDIX C: Volumes delivered from the EDC
ABBREVIATIONS AND NOTATION
3PL Third party logistics
AHP Analytical hierarchy process. A method for decision making
CoG Center of gravity
DC Distribution center
EDC European Distribution Center ERP Enterprise resource planning KPI Key performance Indicator
SKU Stock-keeping unit
1. INTRODUCTION
In global competition, organizations have to continuously search for new ways to lower costs, improve customer satisfaction, and increase profitability. Logistical operations, and especially warehousing, have traditionally been an opportune field for cost savings.
Yet, savings should not be sought for at the cost of service level. A better option is to look for alternatives which avail both parties; customers and the organization serving these customers.
1.1 Motivation
Effective supply chain management is often an efficient way to increase profitability.
Warehouse or distribution center location decisions are one part of the supply chain management. Functional distribution center locations can decrease organizations’ trans- portation costs and cut down inbound and outbound lead times. Lead time shortenings, consequently, make inventory control easier and thus most likely increase service level (Gallmann and Belvedere 2010).
When making a location decision, there are lots of other factors than just lead time and cost reductions that should be considered. The surrounding environment which consists of society, culture and infrastructure among other things, has a remarkable significance to the functionality of the location (Skjøtt-Larsen et al. 2007, p. 402). For example, cul- tural differences may make interaction and communication difficult. Also, if the infra- structure around the distribution center location is weak, ostensibly short distances may be more time consuming than longer distances in an area with a strong infrastructure.
These factors may have an effect not only on the easiness of the operating but widely on the costs and service level.
The nature of spare parts business adds its own characteristics to warehousing and thus also to location decisions. The volatile demand of spare parts increases the need for ef- fective operations (Huiskonen 2001) and fluid relationships. Functional relationships are another important factor when the warehousing has been outsourced to a third party (Jespersen and Skjøtt-Larsen 2005, pp. 150-151). Possible outsourcing partners also occasionally create something of a basis for the location decision. If an organization has decided to outsource its warehousing functions, it has to consider the locations of the service providers in the location selection.
1.2 Case company
The case company of this thesis is Kalmar which is a global cargo handling solutions provider. Kalmar is a part of Cargotec Corporation, which has also two other business areas: MacGregor and Hiab. Cargotec provides a wide range of load handling equip- ment for end-to-end cargo handling solutions. MacGregor offers products and services for the maritime transportation and offshore industries while the equipment of Hiab is used in on-road transport and delivery. Kalmar’s equipment is used in the cargo han- dling solutions and services in ports, terminals, distribution centers and industrial appli- cations. (Cargotec 2013)
Cargotec Corporation was formed in 2005 after the demerger of Kone Corporation.
Nowadays Cargotec operates in more than 100 countries and employs approximately 11 000 people. In 2013 Cargotec’s sales totaled 3.2 billion Euros. (Cargotec 2013) Figure 1.1 shows the development of Cargotec’s total sales and profit margins between the years 2008 and 2013.
Figure 1.1. Cargotec’s total sales and profit margins between the years 2008 and 2013. (Adapted from Cargotec 2010 and Cargotec 2013.)
Kalmar is the market leader in its field, which consists of cargo handling equipment, port automation and services. In 2013 its sales totaled 1 550 million Euros while the operating profit was 4.1 percent. Kalmar’s business has spread out in 33 countries with approximately 5 000 employees. (Cargotec 2013)
0 500 1000 1500 2000 2500 3000 3500 4000
2008 2009 2010 2011 2012 2013
Profit margin Total sales (M€)
Kalmar’s selection includes container and cargo handling equipment such as straddle and shuttle carriers, reach stackers, empty container handlers, terminal tractors and fork- lift trucks. Spreaders, dry bulk handling systems, terminal automation and integration solutions and Navis terminal operating systems are included in Kalmar solutions as well. Kalmar also has an automation product and service offering which covers both equipment and process automation. That equipment is, for example, automated stacking cranes and automated straddle carriers. (Cargotec 2013)
Automation business is seen as one of the greatest growth potential in Kalmar and has been named as the number one cornerstone in Kalmar’s strategy (Cargotec 2014). Fig- ure 1.2. presents all the strategic cornerstones.
Figure 1.2. Cornerstones of Kalmar's strategy. (Adapted from Cargotec 2014) As can be seen in figure 1.2, services are a very important part of Kalmar’s offering. In 2013, 25 percent of Kalmar’s sales came from service business. One reason for the growth of service business is the fact that outsourcing has become more common. Kal- mar Services division covers maintenance, crane services, parts and logistics and sales of pre-owned equipment. Kalmar has the most extensive service network in the world.
(Cargotec 2013) Figure 1.3 presents the share of service business in Kalmar’s sales be- tween years 2011 and 2013.
Figure 1.3. Services, % of total sales. (Cargotec 2013)
In Services division, there is Parts and Logistics business line which is responsible for spare parts sourcing, sales support and the logistics operations between suppliers and customers. Kalmar’s spare part portfolio includes a wide range of different parts such as electrical items, servicing kits, major components and wear parts.
1.3 Research problem, objectives and restrictions
The main purpose of this study is to determine the optimal location for Kalmar spare parts’ European Distribution Center (EDC). The expression “optimal” in this case means a combination of quantitative and qualitative factors. The primal quantitative factor used is the amount of ton kilometers between the distribution center and the cus- tomers. Qualitative factors include political, cultural and logistical attributes which af- fect the quality and the effectiveness of warehousing operations. Thus, the research problem of this thesis is:
• There is no certainty whether the current EDC location is optimal or not.
Consequently, the research question is:
• What is the optimal location for the EDC when both quantitative and qualitative factors are considered?
In order to answer the main research question, it is divided into sub questions as fol- lows:
• Which method should be used when calculating ton-kilometers?
• Which other qualitative factors should be included?
• What are the main challenges for the current EDC location?
• What kind of attributes should be considered when evaluating the qualitative factors?
• How should the different factors be weighted?
• Which decision making method should be used in order to solve the location problem?
The scope of the research is the delivery part of Kalmar’s supply chain. The optimal distribution center location is determined based only on external and internal customer locations. Thus, supplier locations do not have weight in this research. Also, when qual- itative factors are evaluated, the main focus is on service level improvements and not on procurement functions. The main reason for these restrictions is that the supply part was considered not to have as significant importance as the delivery part when making a location decision. In addition, including all the parties would not have been possible in the time frame of this thesis. Figure 1.4 presents the scope of the thesis and the parties that are included in the determination of the optimal location.
Figure 1.4. The scope of this thesis in respect with the simplified supply chain of Kalmar Services
As figure 1.4 presents, the simplified version of the supply chain of Kalmar Services consists of suppliers, distribution centers, front line and customers. The main subject of this research is Kalmar’s European Distribution Center. The scope distribution center is located in France. Locations of the two other distribution centers are not considered, but their influence on the location of the EDC is noted. Thus, the factors which have impact on the location decision are customers, front line and other distribution centers.
Suppliers EDC Front line Customers
DC FI DC
SE
Subject Included
Excluded
1.4 Research approach and methods
The research approach of this thesis is the action oriented approach. The action oriented approach aims to understand the target problem. Subjects are typically phenomena in the internal performance of an organization. The action oriented research approach is based on antipositivistic research philosophy, which means that the relationship be- tween the target and the researcher is dense. (Olkkonen 1994, p. 74; Das 2014) Accord- ing to (Eriksson and Kovalainen 2008, pp. 193-194) he action oriented approach is es- pecially suitable if the research question is about describing series of actions over cer- tain time and in a certain group, organization or other community.
The action oriented research approach combines theory, history and practice around the phenomenon in order to reach objectives. Thus, problems characteristically consist of actual historical data, previous theories and people with their expectations and practices.
(Olkkonen 1994, p. 74) Figure 1.5 presents this point of view in the action oriented ap- proach.
Figure 1.5. Precept of an action oriented research approach (adapted from Olkkonen 1994, p. 75).
The approach of a case study is also utilized in this research. Yin (2009, p. 19) states that a case study is an empirical inquiry which considers contemporary and real-life phenomena. A case study is highly dependent on the context and thus provides findings that generate insight into how the phenomenon actually occurs within a given situation.
A case study is a suitable approach for answering questions that start with how, who or
Subject Theory
Practice
Target
History
why and provides relatively full understanding of the nature and the complexity of the complete phenomenon. The case study approach also enables the integration of qualita- tive and quantitative methods. (Farquhar 2012, pp. 8-9) Eriksson and Kovalainen (2008, p. 116) explain the popularity of case study approach in business research by its capabil- ity to present complex business and management issues in an accessible and easily un- derstandable format.
This thesis is divided into theoretical and empirical study. The theoretical part is based on previous theories that are relevant to answering the research questions. The theoreti- cal research has been done based on scientific literature and journals. The empirical methods that have been used are internal and external interviews, participant and de- scriptive observation, and gathering and analyzing statistical data. Thus, this thesis combines qualitative and quantitative methods. According to Saunders et al. (2009, p.
151), quantitative methods are mainly data collection and analysis techniques which generate or use numerical data. Qualitative methods, on the contrary, generate non- numerical information (Saunders et al. 2009, p 151).
Combining both, qualitative and quantitative research method is called as mixed meth- ods research (Hesse-Biber 2010 p. 3). According to Cameron and Molina-Azorin (2014) it is a coherent approach for business and management research especially when a researcher “tries to innovate, add value or gain greater insights into increasingly com- plex business and management phenomena and discipline based inquiry.”
Saunders et al. (2009, p. 318) state that interviews may help gather valid, reliable and relevant data. Qualitative interviews are based on conversation, as the main idea is re- searcher asking questions and listening, and respondents answering (Warren 2001, p.
83). Interviews in this thesis are done in order to determine the current situation with its benefits and challenges. Also, qualities of the candidate locations are studied through interviewing personnel in the relevant organizations. Interviews in this thesis are semi- structured. It means that there is a prepared outline of topics, issues or themes, but also a possibility to vary questions in each interview (Eriksson and Kovalainen 2008, p. 80).
Overall seven persons were interviewed for this study between December 2014 and February 2015. The total number of the interviews was eleven, because some of the persons were interviewed couple of times.
Quantitative data analysis is used to make raw data useful for the study. Business and management researches most likely include some numerical data that helps answer the research questions. Quantitative analysis techniques range from creating tables to using statistics, to comparisons and conclusions made based on the data. (Saunders et al.
2009, p. 414) This research uses statistical data in order to determine the center of gravi- ty location. Statistical data is also used as the basis of some qualitative comparisons.
Participant observation is used to describe “what is going on”, particularly in social sit- uations. It is a relevant method especially when the researcher is working in the target organization. Consequently, the closeness to the situation may also cause significant observer bias. The term descriptive observation describes observing a physical setting.
(Saunders et al. 2009, pp. 296-299) In this thesis, participant observation is used to de- scribe the current situation and systems. Eriksson and Kovalainen (2008, p. 86) see par- ticipant observation as one of the most demanding ways of collecting empirical materi- als. This is explained with the fact that in order to assure that the observations are of the natural phenomenon, the researcher needs to become accepted as part of the culture, which may take even years. In this thesis, becoming a part of the case company did not take any extra time, because the company was already familiar from the researcher’s previous work history.
1.5 Structure
As the figure 1.6 indicates, the following two chapters provide theoretical background for the study. Both those chapters are based solely on literature reviewing. The second chapter introduces the basics of strategic warehousing and spare part business. The aim there is to point out the main functions of warehousing and the differences between a warehouse and a distribution center. Outsourcing of the warehousing functions and spe- cialties of the inventory control of spare parts are discussed as well.
Location decision theories are introduced in chapter three. Both, qualitative and quanti- tative factors are considered in order to determine all significant inducements behind a location choice. The qualitative factors that are taken into account in this chapter are mainly cultural, political and logistical. This chapter also represents a decision making model that is suitable for combining qualitative and quantitative factors in location deci- sions.
The fourth chapter presents the current situation in the case company. It describes the whole supply chain of Kalmar’s spare parts, from a supplier to a customer. However, the main focus is on the current distribution centers and their locations, and especially in the EDC location. Also the qualities and challenges of the current EDC location are determined in chapter four. These qualities determine the baseline especially for the further scrutiny of the location factors.
Research materials and methods are represented in the chapter five. The first subchapter concentrates on data that is used in analyzing current product flows. Then, the second subchapter describes the use of center of gravity method on the chosen data. Also, quali- tative methods and targets of interviews are represented in the fifth chapter. The utiliza- tion of the Analytical Hierarchy Process (AHP) method is also explained.
The sixth chapter concentrates on the results that have been achieved through the data analysis, interviews, theoretical background and statistics. Those results are also finally combined in this chapter and it leads to the final result of this thesis. Consequently, also the reasons behind the final result are explained more closely. In this chapter the AHP method is widely utilized in order to get the final results.
The last chapter presents the conclusions of this thesis. First, the main results of the op- timal distribution center location are summarized. Then the whole study and its relevan- cy are assessed in respect of the original objectives and research questions. The relevan- cy of the utilized research methods is speculated, too. Finally, some recommendations for further studies are given.
2. STRATEGIC WAREHOUSING AND SPARE PART BUSINESS
Warehousing is an important part of a modern supply chain. Its role depends strongly on the business type. For an organization that sells physical products, warehousing is rarely a key competence (Walker 2010). This fact and a need for cost reductions lead often to the outsourcing of warehousing operations. This chapter presents the theoretical back- ground for strategic warehousing, outsourcing warehousing operations, and warehous- ing in spare part business. These topics are needed to be covered because they create a good base for the understanding of case company’s business and current situation.
2.1 Warehousing functions
The main purpose of warehousing is to ensure the fluent product flow from the vendor to the customer. This is intended to be done as cost effectively as possible. The aim is to benefit both, the customer and the delivering party. Thus, successful warehousing may give direct cost savings but also indirect profits through risen customer satisfaction.
2.1.1 Balancing supply and demand
Ackerman (1997, p. 14) presents two typical situations, where warehousing is needed to balance supply and demand. The first situation occurs if demand fluctuates strongly, for example, along with season changes. In this kind of a situation, it may be impossible to produce or procure a sufficient amount just in time, in which case preparation to de- mand by warehousing products is reasonable. This is a typical situation for season de- pendent products, on whose sale for example Christmas has a huge impact.
The second example presented by Ackerman (1997, p. 14) is a situation where demand is stable but supply for some reason is cyclical. This kind of a situation occurs, for ex- ample, in an organization that shuts down its processes for the holiday season. In that case, the make to stock method is reasonable (Ackerman, 1997, p. 14). Another re- striction for supply could be the growing season, during which a sufficient amount of products should be produced for the rest of the year (Ballou, 2004, p. 471).
Even if supply and / or demand were not dependent on seasons, they are almost never completely synchronized. Producing or procuring a product only for actual demand would in most cases make it extremely time taking to deliver. Consequently, organiza- tions need to prepare for upcoming demand through stocking items. The exact level of
preparation needed depends much on the business field and the items delivered.
(Ackerman, 1997, p. 14)
Stocking also helps risk management. Risks caused by a sudden and unforeseeable fluc- tuation of demand or supply become smaller as extra items are held in stock. For exam- ple, a strike in manufacturing may cause an inability to fulfill demand without stocked items. On the other hand, stocking also causes risks. If demand suddenly decreases, for example, because of the bankruptcy of a customer, stocked items may get out of date or they have to be sold at a lower price than planned. (Ballou 2004, p. 471)
2.1.2 Maintaining service level
Maintaining service level and balancing supply and demand are technically just two sides of the same issue. In practice, a customer experiences short response times as a high level of service. Thus, the availability of products is one of the most significant parameters when the logistics service level is assessed (Gallmann and Belvedere 2010).
Furthermore, the given delivery time and its accuracy are important factors in customer satisfaction (Lutz et al. 2003). Sometimes the willingness to increase customer satisfac- tion is the major reason for warehousing (Ackerman 1997, p. 15). Especially in business fields with strong competition, a delay in availability may cause the loss of a customer, as the customer can choose a competitive product (Greis 1994).
A low service level causes costs that can be seen as costs of shortage. These costs ap- pear when it is impossible to fulfill the demand. For example, back order deliveries with higher transportation costs are caused by insufficiency (Lehmuskoski 1982, p. 109).
Huq et al. (2010) mention also monetary good-will gestures like discounts. These ges- tures are often shown when the customer does not get the product in the promised time.
Consequently, the service level does not only affect customer satisfaction, but also costs and gross return.
Previous studies have mainly focused on pointing out what is the requisite inventory level in order to reach the desired service level. Recently, the relevant research question has been how is it possible to increase service level without increasing inventories. This kind of an approach demands that the whole supply chain is scrutinized in order to im- prove the fluency of the product and the information flow. Therefore, service level is not dependant only on inventories and warehousing functions. Moreover, it is important to consider warehousing as a part of the whole supply chain. (Gallmann and Belvedere 2010)
2.1.3 Reducing unit costs and adding value
Warehousing is often considered as the ”necessary evil”. By contrast, Ross (2004, p.
537) considers it as a possible competitive advantage and a value adding operation. One
of the reasons that ”justifies” the costs caused by warehousing is that through warehous- ing, it is possible to simultaneously decrease costs elsewhere (Ballou 2004, p. 470).
Warehousing may help to reduce unit costs through the economy of scale. This econo- my of scale can be utilized not only in transportation but also in procurement and manu- facturing. Thus, warehousing enables bigger lot sizes. (Ackerman 1997, p. 14)
The purchase prices of some items vary strongly in different points in time. For exam- ple, oil is that kind of a product. If an organization procures these kinds of products, it can benefit strongly if it can purchase them to stock while they are at their cheapest.
This kind of a procedure helps to avoid purchasing when the prices increase. (Ballou 2004, p. 471)
If an organization is multi-sourcing its products, it is often more economical to consoli- date the products to one shipment instead of sending them separately. It can also in- crease the service level as it most likely is easier for the customer to receive only one shipment. Also, if one product consists of many different items, a warehouse is often the combining party. (Stordy 2007) The same idea works also inversely; Items may arrive as mass shipments but are divided into smaller deliveries according to customers’ needs (Ballou 2004, pp. 473-474).
Manufacturing organizations’ warehousing supports the manufacturing operations as well. Not only will mass production most likely save manufacturing costs but for some products, like wine, warehousing may be one step of the manufacturing process. These kinds of products need to be stocked before selling them, so in other words, warehous- ing is a value add to the products. Other value adding warehousing processes are, for example, special packaging or customized labels. (Ballou 2004, p. 472) In addition, for example late customization, which may be a standard part of the manufacturing process, is in many cases executed in the warehouse. Also making product mixes for special events or seasons is possibly done in the warehouse. (Stordy 2007)
2.1.4 Specialties of a distribution centre
Higginson and Bookbinder (2005, p. 68) define a distribution center (DC) as a specific type of a warehouse. So does Ballou (2004, p. 250) who uses also the term distribution warehouse in order to determine this special type of a warehouse. The main difference between a traditional warehouse and a distribution center is that in a DC, the storage of goods is limited or non-existent. Thereby, the DCs focus on product flow rather than on stocking (Higginson and Bookbinder 2005, p. 68). Dawe (1995) adds that while ware- houses store all their products, distribution centers hold only a minimum inventory con- centrating on items with a high demand.
Bancroft (1991) emphasizes the role of a DC as a value adding part of the supply chain.
He explains that traditional warehousing does nothing to add value to the product
stored. Actually, in some cases a long storage time may even have a decreasing impact on value. Dawe (1995), also, is along the same lines as he explains that while warehous- ing adds value only through packing and labeling, a distribution center should have more ways to it. He mentions final assembly operations as an example of a value adding activity that could be done in a DC.
Higginson and Bookbinder (2005, pp. 71-79) determine the six main functions of a dis- tribution center as follows:
• make-bulk or / and break-bulk consolidation center
• cross-dock
• transshipment facility
• assembly facility
• product-fulfillment center
• depot for returned goods
Higginson and Bookbinder (2005, p. 80) emphasize that most DCs have simultaneously more than one of these functions. For example, consolidation and assembly operations have already been mentioned as warehouse functions by other writers (Ballou 2004, pp.
473-474; Stordy 2007). That among other things proves that in real life, it is often diffi- cult to determine exactly whether the facility is a warehouse or a distribution centre.
Most of the times, facilities are somewhere between a traditional warehouse and a DC.
2.2 Strategic warehousing
Rushton et al. (2014, p. 263) estimate that 20 – 30 percent of the logistics costs of an organization are caused by warehousing. Thus, it also forms a significant share of the total costs and affects strongly the finance of an organization. Because warehousing nonetheless provides many remarkable benefits, too, it is very important to pay attention to optimal inventory levels.
2.2.1 Optimizing service level and costs
The capital that has been invested in the products in stock causes income losses that can be evaluated by comparing its returns to returns of another possible investment of the same size. This evaluation is usually made based on the general interest rate. (Abbasi 2011)
The products in stock cause service costs like, for example, taxes, insurance payments and also personnel costs that are caused by people working in a warehouse and among warehousing functions. Warehousing risk costs include costs caused by larcenies and the dating of products, among other things. Previously mentioned shortage cost (Lehmuskoski 1982, p. 109) is also a risk cost. Obviously, warehousing space and
building have their price, too, which depends strongly on the size and the location of the building. (Abbasi 2011)
Generally, organizations try to keep their inventory levels as low as possible in order to cut down the amount of the capital invested in the products in stock and also to reduce other warehousing costs. Usually, demand forecasts are utilized so that the inventory levels meet with the real demand at the best possible accuracy. However, correctness of the forecasts is never perfect. In addition, order lead times to the stock may vary strong- ly, which means that a product is not in stock even if it was planned so. (Jeffery et al.
2008)
Baker (2008) considers external integration, such as close customer or supplier co- operation, as a part of an effective supply chain. Thus, he states that, for example, just co-operation with a customer is a practice which helps to achieve a situation where de- mand is well-predictable. Good predictability results in optimal inventory levels and effective responding to the actual demand. Close co-operation with suppliers, in con- trast, may lead to shorter and more reliable lead times. Also Murphy and Wood (2008, p. 95) estimate that accomplishing the service level that satisfies customers requires listening to customer opinions and expectations for the lead times of different products.
Ballou (2004, pp. 314-315) also sees co-operation as a good method in order to create more accurate demand forecasts. He suggests that co-operation should be done not only outside but also inside the organization between different departments. Professionals with different backgrounds give their own skills and experience to the forecasts. Also Gallmann and Belvedere (2010) emphasize the significance of accurate demand fore- casts. Correctly established forecasts may reduce the need for high inventory levels and thus lower the warehousing costs. However, if the demand is very unstable, forecasting may be almost impossible. In that case, it may be more reasonable to put effort into the flexibility of the supply chain instead of forecasting. (Ballou 2004, p. 317)
On the other hand, the satisfactory service level is not an absolute value, and thus it de- pends on the expectations of the customers. That is why the adequate service level can be determined by comparing the organization’s own processes to the similar processes of the competitors. This kind of benchmarking gives important information about the field of competition. There may not be a point in having an excellent service level if all the competitors are notably weaker in that area anyhow. (Murphy and Wood 2008, p.
95)
Jeffery et al. (2008) claim that an optimal inventory level strongly depends on the prod- uct type. Fisher (1997) agrees with that. He states that the supply chain of functional products does not have to react to demand as rapidly as in the case of innovative prod- ucts. Thus, the stock level of innovative products should be higher. Also, for example, the life cycle of a product affects the required stock level (Greis 1994). The phase of the
life cycle should be noted as well (Greis 1994). If an organization has a monopoly on a product that is crucial for the customer, high service level is not necessary. On the other hand, if there are lots of substitutive products in the market, high service level may even be the only selection criterion. (Murphy and Wood 2008, p. 95)
Customer service responsiveness is not an unequivocal concept. Satisfaction with a cer- tain service level may vary among customers even if the order fulfillment rate was simi- lar for all of them. Customers may have individual needs and appreciate different quali- ties. Consequently, measuring service level should be done by taking into account many different factors in total order cycle and also by paying attention to the individual needs of each customer. (Lee and Billington 1992)
Gallmann and Belvedere (2010) present a theory that not only the inventory level con- trol but also the operative management of distribution centers affects strongly the re- ceived service level. The high number of SKUs increases the need of effective operat- ing. It means that service level depends also, for example, on the layout and the person- nel’s competence.
2.2.2 Following the main strategy
Ross (2004, p. 550) claims that distribution centers and warehouses should be consid- ered as parts of the organizations main strategy and not as separate units. Thus, for ex- ample, marketing and manufacturing strategies should be strongly linked with the logis- tics strategy and further with service level goals. In practice, it means that the service level target, defined by the marketing strategy, should be considered when making pur- chase or manufacturing orders.
In order to determine the needed service level that corresponds with the strategy, an organization has to be able to understand its current situation as accurately as possible.
Also, an organization must have an objective image of the role of its distribution centers in the supply chain. Thus, warehousing should execute its tasks effectively in the supply chain. When the roles are clear, it is possible to make coherent conclusions about the future and the changes needed in the service level. (Aiello 2007)
Lapide (2013) states that as warehousing has become more and more important, it is time to set the warehouse goals in line with corporate wide strategy. He claims that tra- ditionally, warehousing objectives have focused being productive, fast, cheap and accu- rate but now it is time to supplement these goals with value-oriented objectives. He em- phasizes the focus among three types of operational performance objectives: efficiency, asset utilization, and customer response. Figure 2.1 represents the triangle of these warehousing objectives.
As figure 2.1 indicates, operational warehousing decisions should be in line with the corporate-wide objectives. Those goals are achievable, if the whole supply chain team works in unison in order to balance all three sectors of the warehousing performance triangle. (Lapide 2013)
Also Ballou (1997) describes a logistics strategy as a triangle which consists of a loca- tion strategy, a warehousing strategy and a transportation strategy. More closely, inven- tory strategy includes decisions about inventory level, deployment of inventories and control methods. Transport strategy consists of decisions about modes of transportation, carrier routing and scheduling and shipment size and consolidation. Location strategy then, covers decisions about locations, number and sizes of facilities, like warehouses and DCs, assignments of stocking points and outsourcing. Implementation of these three strategies impacts on the quality of customer service. However, the contents of each partial strategy depend strongly on the organization and its business and situation. Fig- ure 2.2 represents these partial strategies and their common objective in customer ser- vice.
Aligning Warehouse Operational Perfor- mance to Business Goals Customer Response (Customer-Facing)
- On-time Shipments - Perfect Order Fulfillment
- Cycle Times
Efficiency (Internal) - Labor Productivity - Warehousing Costs
- Order Process
Asset Utilization (Internal) - Warehouse Throughput
- Overflow Storage - Product Spoilage
- Cash Flow
Figure 2.1. Dependence between warehousing objectives and business goals (Adapted from Lapide 2013)
Figure 2.2. The triangle of logistics strategy (Adapted from Ballou 1997) As it can be seen in figure 2.2, this view, too, considers warehousing as a part of an en- tirety and not as a separate field. Each sector of the logistics strategy has its impacts on the service level, profitability and thus on the main strategy. (Ballou 1997)
2.3 Outsourcing the warehousing functions
As a result of tightening competition, organizations often decide in their main strategies to concentrate their core competencies. Make or buy decisions received an important role in the area of logistics and as a part of organizations’ competitive strategy in early 90’s (Bardi and Tracey, 1991). Consequently, warehousing has become the most fre- quently outsourced logistics activity (Moberg and Speh 2004). According to Reeves et al. (2014), companies have three alternative options for their outsourcing strategy:
1. Develop and provide logistical services internally (insourcing).
2. Procure the services from a third party logistics firm
3. Hybrid approach where some of the services are provided in-house and others are outsourced
If a company has decided to outsource its warehousing functions, it is typical that it chooses the third option partly outsourcing and partly insourcing its services. Relph and Parker (2014) have divided this kind of a hybrid approach into three levels. The first level comprises only basic warehousing services. At the second level, there are some value added activities like labeling. The third level then is near to the complete sourc- ing. In that option, the third-party logistics (3PL) provider takes care of, for example,
Customer Service Goals
Inventory Strategy Transport Strategy
Location Strategy
the inventory management. Figure 2.3 represents the levels of outsourcing and the fac- tors that should be considered when determining the optimal level of outsourcing.
As the figure 2.3 indicates, various qualities affect the selected level of outsourcing. The selected level of the outsourcing then affects further to the whole performance of the warehousing. Relph and Parker (2014) state that there are three major reasons to drive the desire of an organization to outsource part or all of its functionality. These three reasons are cost, strategy and politics. Razzaque and Sheng (1998) agree that along with concentration on core competencies, there are many other motives for outsourcing warehousing functions. Bardi and Tracey (1991) add that labor cost savings are often the most important driver for outsourcing.
Third-party logistics providers are capable of producing the same operations at lower costs as those operations are their core competence. Consequently, they have strong expertise, gained from working with other clients, which can help improve customer service. Furthermore, in global logistics, an external operator may have a better under- standing of its region of operation. (Razzaque and Sheng, 1998) Willingness to reduce capital investment is a driving force for outsourcing warehousing functions. By out- sourcing those activities, an organization avoids investments in area and buildings. In addition, it does not have to acquire assets like warehousing equipment and software.
(Bardi and Tracey, 1991)
Performance
Figure 2.3. Factors behind the selected level of outsourcing and the dependence to performance (Adapted from Relph and Parker 2014)
Presently, outsourcing is increasingly extending across international borders and is as relevant today as in the past (Reeves et al. 2014). Mello et al. (2008) state that interna- tionalization has increased the demand for outsourcing. They claim that the use of third- party logistics support for global supply chain execution actually creates competitive advantages in a global supply chain.
Outsourcing warehousing functions has its problems, too. Bardi and Tracey (1991) state that loss of control is the greatest obstacle for outsourcing. Along the loss of control comes often the loss of touch with important information. However, the observations of Bardi and Tracey (1991) indicate that the loss of control should not be considered as a real obstacle if outsourcing is otherwise a reasonable option. Still, many outsourcing problems like poor communication and unsatisfactory availability of information impli- cate a weak partnership. Strong relationships are a consequence of close, long-term co- operation. Through strong partnerships it is possible to achieve the whole competitive advantage that outsourcing enables (Razzaque and Sheng 1998). Mello et al (2008) em- phasize the role of confidence-building, too. They state that it is not only the perfor- mance of 3PL providers but also personal feelings towards providers that create a feel- ing of mutual confidence.
Ansari and Modarress (2010) have listed the biggest challenges in logistics outsourcing.
One of the problems is that the 3PL provider may be incapable of meeting the custom- er’s specific logistics requirements. Some businesses, for example, have very specific requirements for warehousing equipment and systems. Secondly, technology may now- adays cause incompatibility problems if, for example, the information systems of the service provider and the customer cannot be integrated. Thirdly, Ansari and Modarress (2010) present the concern of the 3PL failing to meet the customer’s future growth needs. The fourth challenge listed by them is the familiar lack of control, discussed ear- lier in this chapter.
The selection of a warehouse operator is an important decision which may have remark- able impacts on the performance of the organization. If an organization outsources its warehouses, location decisions often include also a decision of a warehouse operator.
Maltz (1995) emphasizes the importance of a proper supplier selection procedure. By the proper procedure, the organization is able to choose the best suitable partner for it.
The first aspect that should be considered is why to outsource. This means determining the main objectives of outsourcing. After that it is easier to evaluate different service providers.
Also Jespersen and Skjøtt-Larsen (2005, pp. 150-151) state that behind every co- operative partnership there is a careful analysis of alternative partners. They notify that there is a risk of a lock-in with the wrong partner and in order to avoid it, it is crucial to take into account all the aspects that may have an impact on the partnership. This kind
of an analysis should be done for both, short-term and long-term aspects and it should include an assessment of the benefits, drawbacks, possibilities and threats.
The first step of the provider evaluation process is to truly understand the characteristics and capabilities of third-party logistics providers (Razzaque and Sheng 1998). Maltz (1994) claims that the quality of services is more important than low prices. Korpela et al. (2007) have scrutinized the quality and service capabilities of 3PL providers. They have created a warehouse operator service capability evaluation model which includes reliability and flexibility factors. The criteria of this model are presented in figure 2.3.
Figure 2.3. Evaluation criteria for warehouse operator selection (Korpela et al.
2007)
As figure 2.3 represents, two main factors for prioritizing warehouse operators’ service capabilities are reliability and flexibility. Reliability includes factors like delivery time, quality and quantity. The factors impacting on flexibility are capability to fulfill urgent deliveries and special requests but also frequency and capacity. Moberg and Speh (2004) have found similar factors but have not done the similar division than Korpela et
TO PRIOTISE THE WAREHOUSE OPERATORS BASED ON SERVICE CAPABILITIES
RELIABILITY
DELIVERY TIME
QUALITY
QUANTITY
FLEXIBILITY
URGENT DELIVERIES
FREQUENCY
SPECIAL REQUESTS
CAPACITY
al. (2007) have. They claim that the top four selection criteria are responsiveness to ser- vice requirements, quality of management, track record of ethical importance and ability to provide value-added services.
2.4 The role of warehousing in spare parts business
It is important to know the specialties of spare parts business in order to understand the special features of storing spare parts. Spare parts inventory management differs from traditional inventory management in many special requirements and characteristics (Wang 2012). The goal of spare parts management is to minimize the total cost of in- ventory holding, stock-outs, and ordering (Lawrenson 1986).
Spare parts, which are also known as service parts or spares, are needed when technical installations fail. They are also used in planned maintenance (Fortuin and Martin 1999).
Kennedy et al. (2002) notify that spare parts are never final products to be sold to a cus- tomer. They determine that the function of spare parts is to assist in keeping equipment in an operating condition. Thus, the spare parts business can be seen as service business (Wood et al 2002, p. 396). Spare parts themselves can be divided into two different cat- egories: repairable and non-repairable (or consumable) (Fortuin and Martin 1999). Re- pairable parts can be switched to new ones while the faulty ones are fixed for reutiliza- tion. Non-repairable parts cannot be overhauled, so the faulty ones are just to be dis- posed. Gopalakrishnan and Banerji (2004, p. 232) emphasize that even though spare parts may look small and be much cheaper than the machine or the raw material, they have a crucial role in maintaining, ensuring and reinforcing the reliability of any equip- ment. The spare part business itself has three main phases: procurement, warehousing and sales (Suomala et al. 2002).
Suomala et al. (2002) find two groups of spare part orders: normal and emergency. A normal order is placed for planned maintenance routines. However, it is quite typical that customers need emergency parts outside normally planned maintenance schedules.
That is often why a spare parts inventory is held. An inventory is also often divided by its criticality. It means consideration of the consequences to the customer if an item is needed and not available (Botter and Fortuin 2000).
Huiskonen (2001) claims that the demand for spare parts may be extremely volatile and thereby it is difficult to forecast. Also Boone et al. (2008) find the inaccuracy of service parts forecasts a great challenge. They even claim that “the old adage that the forecast is always wrong is certainly applicable to service parts”. The weak predictability of the demand results from the fact that equipment or part failures are sporadic. However, as in any other inventory management issue, capital is tied up to maintain high inventories of spare parts. The results from that are high costs and consumption of investment capital, which could be used in more profitable ways (Roda et al. 2014).
Gopalakrishnan and Banerji (2004, pp. 232-233) state that spare parts are often uneco- nomical to manufacture. In addition, the demand of spare parts is often very small whereas the product variety is large. All that makes spare parts inventory management a complex and an important area of logistics strategy.
Customer service level decisions are often in an important position in spare parts inven- tory management. Because a simple component failure situation may cause remarkable losses for the customer, stock out situations are even more harmful for service level than in normal business (Minner 2011, p. 160). Furthermore, lead times for spare parts may be long and it is hard to give accurate lead time information for customers (Boone et al.
2008).
One challenging task in spare parts management is minimizing parts obsolescence (Boone et al. 2008). Also Suomala et al. (2002) pay attention to the life cycle considera- tion of the items. The reason is that in firms manufacturing industrial equipment, the life cycles of the products may be decades. That generates a problem: where to find spare parts for the equipment manufactured, for example, 30 years ago. Boone et al. (2008) as well consider the part obsolescence as one of the greatest risks in the spare part busi- ness. They mention that with rapid changes in product introduction and design, there is a huge challenge to minimize investments in parts subject to obsolescence while keep- ing up the strategic level of customer service.
3. OPTIMAL DISTRIBUTION CENTER LOCATION
Location decisions are a crucial part of an efficient supply chain planning. Other ware- housing decisions, concerning, for example, transportation or inventory, can often be changed in a short notice whereas decisions about location are less flexible. Changing a facility location is typically a challenging and arduous project which consumes both material and immaterial resources. As location changes cannot be made frequently, they should be planned meticulously by experts. (Daskin et al. 2005) According to Stevenson (2011, p. 340), there are four steps in making a location decision. Those steps, also fol- lowed in this thesis, are as follows:
1. Decide on the criteria that will be used to evaluate location alternatives 2. Identify criteria that are important
3. Develop location alternatives
4. Evaluate the alternatives and make a selection
This chapter introduces various criteria which are often utilized in location selection.
Also, an evaluation model for the criteria is represented. These theories are then used later as a base for the empirical part of this thesis.
3.1 Logistics strategy and warehouse location
As in all other warehousing decisions, location decision should be made at lower costs but also to reach the service level goals. Chopra and Meindl (2007, p.124) give an ex- ample that a model of many local facilities may reduce transportation costs and lead times but at the same time also increase warehousing costs and make the system un- clear. Ballou (2004, p. 550) points out that the location strategy, consisting of location decisions and network design, is an important means to reach customer service goals.
He discusses facility location as the “bones” of the supply chain meaning that facility location is the basis for other logistics management decisions.
Huiskonen (2001) finds four elements in logistics system design. Those elements are network structure, supply chain relationships, coordination control and strate- gy/policies/processes. The figure 3.1 demonstrates how these strategic goals are related to a network structure and supply chain relations.
Figure 3.1. Elements of a logistic system design (Huiskonen 2001)
As figure 3.1 indicates logistic system is a complex system, of which parts are not only linked to each other via coordination and control but also affect each other directly.
Network structure decisions include the number of inventory echelons and locations used in the system. Consequently, location decisions are an important part of the net- work design. (Huiskonen 2001)
3.1.1 Cost savings
When it comes to warehouse location decisions, economical factors often dominate (Ballou 2004, p. 551). Maybe the most obvious cost saving opportunity in relocating a warehouse is to lower inbound and outbound transportation costs. Transportation costs depend often quite linearly on distances between warehouses and customers or plants / suppliers. Transport cost minimization was discussed already in 1929 by Weber (1929, pp. 41-42). He uses a simple ton-kilometer optimization to determine the optimal facili- ty location and to minimize the total travel distance between the site and a set of cus- tomers.
Shorter distances mean lower transportation costs almost without exception. Krajewski et al. (2007, p. 432) uses the term load-distance method to describe the method which can be used to select a location that minimizes the distances that loads travel. The load- distance method is a mathematical model used to evaluate optional locations based on proximity factors. The meaning of a load depends on the case industry and it may be, for example, shipments from the suppliers or to the customers. Distance can also be replaced with time, if it is reasonable.
Coordination / Control
Strategy / Policies / Processes
Supply chain relationships Network
structure
Krajewski et al. (2007, p. 432) explains how the load-distance method can be used to calculate a load-distance score of a certain location. The organization seeks to minimize its load-distance score by choosing the location which leads to the shortest distances.
The formula for load-distance score is
where
= load-distance score = load of a certain location
= distance to the location
The goal is to find one acceptable facility location which minimizes the score. However, there are many other factors that should be considered in order to reduce costs.
Mentzer (2008) presents three basic economic factors in location decisions: land, labor and capital. A dense land-area makes building a new warehouse more expensive as the site prices are higher than in looser areas. Even in public warehouse cases, high density most likely raises the prices. Labor costs depend closely on the income level of the area.
Sometimes there is a possibility for great savings in labor costs when the location is moved to a neighboring country. The economic factor of capital means that there are occasionally economic incentives to companies that decide to set up a facility in a cer- tain location. This may mean, for example, tax degradations or low-interest develop- ment loans.
Huang et al. (2012) pay attention to the opportunity of getting lower supplier prices by locating the warehouse correctly. They claim that not considering the supplier prices when locating a warehouse is a significant omission. In that theory, the optimal loca- tions gravitate towards locations of the suppliers offering lower prices. However, if the price variability is high, the optimal location moves towards the demand’s center of gravity. In those cases, it is beneficial for the organization to keep the location near that center of gravity and pay less attention to the supplier prices and supplier locations.
Melachrinoudis and Min (2007) point out that warehouse consolidation may provide cost savings due to the economics of scale. They prove that redesigning the warehouse network can help an organization to save transportation, inventory and warehousing costs. Fewer warehouses cause lower handling costs and also decrease transportation costs due to the increase in opportunities for large-volume shipments. However, consol- idation, despite of its cost saving opportunities, lengthens lead times therefore deterio- rating customer services.
3.1.2 Service level
Korpela et al. (2001) claim that the main problem in the traditional approaches to supply chain design is that they underrate the role of customer service. The focus is typically on the deliverer's point of view. Thus, the scope should be expanded from the traditional approaches to a more customer oriented direction. Ho and Perl (1995) agree with that opinion. They explain that customer service and cost savings are rather two sides of the same case, not separate goals. Therefore, customer service level should be considered as an element of the location objective. Ballou (2005, p. 653) claims, though, that custom- er service level improvements and the resulting revenues do not have a reliable relation- ship. He states that they should be considered rather as an adjustable constraint which can be changed in order to see the effect on total costs. In any case, service level is an important factor when the location decisions are made.
Chopra and Meindl (2007, p. 124) claim good location decisions can improve the re- sponsiveness of the whole supply chain. In contrast, a poor location can make it impos- sible to achieve the desired service level. To achieve high responsiveness, the ware- house should be as near the customer as possible. Although there are often numerous customers and it is impossible to have a warehouse near every one of them. That is why an optimal location should be found. Also Boone et al. (2008) describe the distribution decision as crucial to providing the necessary flexibility to meet customer demands and to achieve the desired levels of customer service.
An organization has often many kinds of customers: some of them value, for example, short lead times more than the others. It should also be considered when finding the optimal location (Chopra and Meindl 2007, pp. 115-116). Also Korpela et al. (2001) emphasize differences among customers and their effect on supply chain design. There- fore, customers’ preferences for customer service should be analyzed carefully.
Ashayeri and Rongen (1997) add that a functional warehouse location should be seen as a part of value-added logistics where an effective supply chain increases the value that the customer experiences.
To enable the improvements in service level, an organization should figure out the cur- rent state of its services. This can be done through simple questionnaires or interviews where customers’ expectations and satisfaction are investigated. It is also useful to get to know the levels of service of the competitors. (Ballou 2004, pp. 652-653)
When making, for example, location decisions, strategic importance of each customer should be determined (Korpela et al. 2001). Baumol and Wolfe (1958) explain that sometimes location decisions have a direct influence on demand. Alizadeh (2009, pp.
488-489) notifies that in profit-maximizing purposes it is not always the best option to satisfy the need of all the customers. She claims that in competitive situations, it may be
